A Regulatory Safe Harbor for Derivatives

A comprehensive and consistent regulatory framework for the US derivatives market is an important objective from public policy, risk mitigation and market liquidity perspectives. However, due to differences in the timing and substance of the rules implemented and/or proposed by the two primary US markets regulators – the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) – this objective is not being achieved.

Policy-makers and market participants have been discussing potential solutions for years, but haven’t settled on a fix that would reduce regulatory and compliance burdens while preserving the authority of the respective agencies. For example, some have suggested that the CFTC and SEC undertake a rule-by-rule gap analysis and harmonization effort. However, such an effort would be costly and likely take years to complete. Others have proposed shifting statutory authority from one agency to the other, but this solution ignores the historic oversight and unique role of each agency (and their Congressional authorizing committees).

This paper suggests a potential solution: a regulatory safe harbor mechanism that would allow firms to rely on their compliance with one commission’s rules to satisfy comparable requirements set by the other commission. This would ensure regulatory oversight over the entire market, while also enabling market participants to reduce the complexity and cost of complying with two similar but not identical regulatory regimes. The commissions could implement such a solution by adopting exemptive orders in line with their respective statutory authorities. This safe harbor mechanism could complement current efforts to achieve harmonization between the commissions’ rule sets and should provide immediate relief to market participants, increasing the number of liquidity providers and, potentially, improving overall market liquidity.

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